Franklin BSP Realty Trust, Inc. Q4 FY2022 Earnings Call

Good morning. Thank you, Chad, for hosting our call today. Welcome to the Franklin BSP Realty Trust fourth quarter earnings conference call. As the operator mentioned, I'm Lindsey Crabbe, Director of Investor Relations. With me on the call today are Richard Byrne, Chairman and CEO of FBRT; Jerome Baglien, Chief Financial Officer and Chief Operating Officer of FBRT; and Michael Comparato, Head of Commercial Real Estate at BSP. Before we start today's conversation, I want to mention that some of today's comments from the team are forward-looking statements and are based on certain assumptions. Those comments and assumptions are subject to inherent risks and uncertainties as described in our most recently filed SEC periodic reports, and our actual future results may differ materially. The information conveyed on this call is current only as of the date of this call, February 23, 2023. The company assumes no obligation to update any statements made during this call, including any forward-looking statements, whether as a result of new information, future events, or otherwise, except as required by law. Additionally, we will refer to certain non-GAAP financial measures, which are reconciled to GAAP figures in our earnings release and supplementary slide deck, each of which are available on our website at www.fbrtreit.com. We will refer to the supplementary slide deck on today's call. With that, I will turn the call over to Rich Byrne.

Great. Thanks, Lindsey. Good morning, everyone, and thank you for joining us today. I am Richard Byrne, Chairman and CEO of FBRT. Our earnings release and supplemental deck were published on our website yesterday. This morning, we will review our financial results for the fourth quarter and the year ended 2022. I will start on Slide 4, highlighting FBRT's milestones throughout 2022. We closed $209 million in new loan commitments in the fourth quarter, bringing our total for 2022 to $2.3 billion at a weighted average spread of 462 basis points. Our commercial real estate portfolio ended the year with a principal balance of $5.3 billion spread over 161 loans. Importantly, we successfully liquidated and recycled the capital underlying nearly all of the $7.1 billion of ARMs from Capstead’s merger into our commercial real estate portfolio ahead of schedule, achieving our target for positive distributable earnings dividend coverage by year-end. Our overall portfolio is well-positioned, with 76% of our loans allocated to the multi-family sector, which we believe will remain resilient and offers strong risk-reward potential. We issued two managed CLOs in the first half of '22, raising over $2 billion, both with two-year reinvestment periods. Therefore, non-recourse and non-mark-to-market liabilities now account for 78% of our core portfolio. We ended the year with substantial liquidity, holding $179 million in cash and $1 billion in total liquidity. FBRT and our advisor, Benefit Street Partners, actively repurchased stock in 2022, with FBRT buying approximately $16.6 million of common stock in the third and fourth quarters. We have just over $48 million remaining on our buyback authorization, extended through December 31, 2023. Benefit Street Partners also purchased $35 million of common stock in the second and third quarters, leading to total purchases of $52 million at favorable levels. Overall, we executed our strategic plan for 2022, seeing growth in our portfolio, strengthening our credits, and positioning ourselves well in various aspects, including our liability structure. Now, I would like to focus on the fourth quarter specifically. We generated $0.37 in distributable earnings for the fourth quarter, a 12% increase from the prior quarter, with a distributable earnings return on equity of 9.2%. Our dividend coverage was 104%, and our fourth-quarter common dividend remained steady at $0.355, the same for the past six quarters, delivering a yield of around 9% on our 12/31 book value. The average risk rating of our portfolio slightly increased this quarter from 2.1 to 2.2. We added two loans to our watch list and three positions to foreclosure REO, two of which were previously on the watch list, including one related to our Walgreens portfolio. Jerry and Mike will provide more details on our REO and watch list assets shortly. Notably, 71% of our performing loan portfolio was originated in the last 18 months, leading to a relatively muted near-term maturity profile. In conclusion, we are confident in the quality of our diversified portfolio, primarily within the multi-family sector. With low leverage and ample liquidity, we are prepared to navigate market challenges that may arise due to persistent high interest rates or a potential economic slowdown. We look forward to pursuing new origination opportunities throughout the year, as we believe the environment will become more favorable as values adjust and new capital becomes necessary. Now, I will hand it over to Jerry to discuss our quarterly performance.

Thanks, Rich. Good morning, everybody. This is Jerry Baglien, like Rich mentioned, I'm the CFO and the COO for FBRT. Thanks for being on the call today. I'm going to jump into Slide 5. In Q4, FBRT generated distributable earnings of $38.8 million or $0.37 per fully converted share. That represents a 9.2% ROE. A walkthrough of our distributable earnings to GAAP and income can be found in the earnings release, definitions are at the far back as well if that's helpful. Our commercial real estate portfolio ended the quarter at $5.3 billion in principal balance. Deal flow in the broader market continued to be lower during the quarter, but we selectively originated $209 million in new commitments. Spreads on these loans continue to trend modestly higher than what we saw in the first half of the year. Our total real estate securities this quarter increased to $457 million with $221 million in CRE CLO bonds and $236 million in remaining ARMs. Subsequent to the end of the quarter, we paired this back a little bit and we sold $128 million of the CRE CLO bonds and another $98 million of the ARM bonds both at slight gains in the first quarter. We view our leverage position as a structural highlight with net leverage ending the quarter at a very conservative 2.5x, and on a recourse leverage basis, much lower at 0.68x. The last thing I wanted to discuss on this slide is our fully converted book value. While we received a benefit from buying back shares and retaining capital from over-earning our fourth quarter dividend, our book value declined modestly to $15.78 and this is mostly a result of the CECL reserves and some non-cash mark-to-market on the remainder of that ARM portfolio. Moving on to Slide 6, you'll see we had our third consecutive quarter of distributable earnings growth, and over the quarter we saw an approximate 140 basis point increase to SOFR and this continued to provide increases in benefits to our earnings. Moving to Slide 7, this walks you through the activity in our portfolio for the quarter and the year ended 2022. I've already touched on fourth quarter originations. A few other things to note on this slide. We received $247 million in loan repayments in the fourth quarter, and we transferred out $82 million in foreclosures or deed in lieu of foreclosures. For the year, our total commitments grew by $1.1 billion or 23%, and we ended the year with total commitments of $5.9 billion. Regarding our REO, we added two new positions this quarter in addition to part of the Walgreens portfolio. We've not taken an impairment charge on these two assets that were added. We have begun marketing these and we intend to sell them in the near term. However, if we do not achieve the desired pricing, we are more than comfortable owning and operating these assets for a longer period of time. Our watch list is composed of five loans, four of those are rated a 4 and Walgreens, which is rated a 5. Our watch list loan balance represents 4.2% of our portfolio, and Mike will touch on the watch list assets in a little more detail later. On Slide 8, we have an overview of our capitalization. Our financing sources are diversified and as Rich mentioned, over 78% of our financing on our core book is non-recourse and non-mark-to-market, and this further demonstrates our conservative posture and an ability to withstand continued market volatility. Finally, Slide 10 showcases our liquidity position. As Rich mentioned previously, we ended the quarter with $1 billion in total available liquidity, and this is a combination of cash on hand, available CLO reinvest, and capacity on our warehouse lines that we can access. Our warehouse lines are diversified with six separate counterparties at year-end. Our liquidity stabilizes our balance sheet and will enable us to take advantage of future origination opportunities. With that, I'll turn it over to Mike to give you an update on our portfolio.

Thanks, Jerry, and good morning, everyone. Thank you for joining us. I'm Mike Comparato, Head of Commercial Real Estate at BSP, and I'm going to start on Slide 12. Our commercial loan portfolio consists of 161 loans, of which 99% are senior mortgages and 98% are floating rate. The portfolio is predominantly multi-family with 76% of the portfolio invested in that asset class. You'll see our geographic footprint remains largely unchanged from the prior quarter with our focus continuing to be across the Southeast and Southwest. Notably, we have no international exposure and have no intention of adding international exposure in the future. Similar to last quarter, office exposure continues to be a focal point for the market and one I want to further expand on. After quarter end, our second largest office loan was repaid in full. Our largest office loan is a triple net leased asset leased for over 15 years to a large public company as their corporate headquarters. Our traditional multi-tenant office exposure, when excluding this loan and the loan that just repaid, is only 5.2% of the total portfolio and has an average loan exposure of only $23.9 million. We believe our office portfolio to be very manageable at these levels. Moving to Slide 13, this shows our activity specifics for the fourth quarter. We originated eight loans in the quarter for a total commitment of $209 million and multi-family continued to be our largest add with over 79% of originations in that sector. Our average loan size of $33 million allows us to be incredibly selective on credit quality given the size of the middle market space. As we have discussed for several quarters, negative leverage continues to be an issue and one that may not resolve itself quickly. We believe a meaningful amount of cap rate widening still needs to occur in both the multi-family and industrial sectors. Transactional deal flow on tighter cap rates assets continues to be limited, although we have seen a meaningful increase in deal flow for the first six weeks of the year versus the fourth quarter, and I'm pleased to say we have the largest forward pipeline that we have had in almost six months. Finally, on Slide 14, we have five loans on the watch list and three positions as REO as of December 31. Jerry already talked about the REO, but I will provide a little more detail on the Walgreens REO and our watch list. On the two loans that were added to the watch list this quarter, both were assigned a loan risk rating of 4. Those were a CBD office complex and CBD limited service hotel, each with a carrying value under $40 million. We are in close communication with the borrowers on each loan. Both loans are current through today, and the limited service hotel is going through a sale process. Our high-rise apartment building was put on the watch list in the third quarter and remains rated at a 4. We have come to modification terms with the borrower that includes a meaningful investment of new equity. We hope to finalize a formal loan modification in the coming weeks. The other two loans on the watch list are our Walgreens retail portfolio and the Brooklyn Hotel. Both are still involved in ongoing legal proceedings, so our commentary is limited. The Walgreens portfolio continues to be in litigation. However, through today, we have foreclosed on 13 of the properties and expect to foreclose on the remaining 11 this year. We have made some very positive steps on the Brooklyn Hotel asset. The hotel has gone through the bankruptcy sale process and the final sale price is $96 million. We expect there to be a gain associated with this asset upon the exit from bankruptcy and after payment of various expenses. While we expect that to happen in 2023, the conclusion of the process and the exact timing are outside of our control. With that, I would like to turn the call back over to the operator to begin the Q&A session.

And the first question is from Steven DeLaney from JMP Securities.

Congratulations on an impressive performance in your first year as a public company. Considering the portfolio at $5.3 billion and your leverage at 2.5x, as we look to model for 2023, do you believe that the portfolio will stay around the same level, perhaps between $5 billion and $5.5 billion? Or is there a possibility for some growth in the portfolio, especially if you were to pursue another CLO or seek additional capital?

Jerry, do you want to tackle that question or Mike, yes?

Thank you for the question. Look I think we're coming into the year overall with a defensive posture. We think we have a lot of tailwinds coming our way both in terms of SOFR, and then specific to our portfolio with the resolution of the hotel and hopefully the resolution of the Walgreens portfolio. So we've positioned ourselves with a lot of liquidity as we talked about. And historically, I think if you look at us as a platform, we've been opportunistic in times of dislocation. I think we were one of the first lenders that started lending out of COVID. And as opportunities present themselves through this marketplace, we very much would like to expand the balance sheet if the right credit and returns present themselves. So, I think we're clearly very happy with where we are today at dividend coverage. We have those nice tailwinds, but if we can add what we believe to be good risk-return profiles we absolutely will be adding.

That's helpful, Jerry. Can you provide a rough estimate regarding the impact of the ratings? Let's consider it in terms of accruals versus non-accruals. If all of these issues were to be resolved and the capital deployed, how much impact would that have on your portfolio? Specifically, what percentage of your $5.3 billion portfolio is currently not generating income on a run rate basis?

It's two loans. This is Jerry. It's Williamsburg and Walgreens, which are on non-accrual at this point. The other watch list is still on accrual.

It's okay. I don't have the deck open. What do those two loans, Williamsburg and Walgreens, add up to in terms of dollars?

Call it $150 million for easy rounding. So, you're talking about repurposing that equity on a go-forward basis. Now, the only caveat I'd add there is, we still get rents on Walgreens, so there's some contribution there, but it's obviously not commensurate with the returns that we would earn on our normal loan portfolio. So, there's a fair amount of upside as we free up some of that equity and turnover those positions.

Steve, it's Rich. I believe you hit the nail on the head. We've always provided a range of leverage that could exceed 2.5, but given the amount of debt capital we hold, consider the Brooklyn Hotel which has been in bankruptcy for years; it represents unproductive capital that we hope will be revitalized as Jerry mentioned, along with our available cash. We have substantial capital to manage before we even contemplate increasing our leverage opportunistically. Additionally, considering the current state of the markets and our liquidity position, we have plenty of flexibility.

Yes, no question. But you've got some tailwinds and you've got some, let's just say, underutilized capital in those couple of assets. So thanks for the comments and all the best for 2023.

Next question is from Jason Stewart from Jones Trading.

This is Matthew standing in for Jason. Congratulations on a strong quarter. Are the people in the pipeline repeat borrowers, or what is their composition? And could you discuss your sponsor strength?

Sure, Matt. Thanks for the question. This is Mike. I think it's a mix of repeat borrowers, repeat brokers as well as some new clients. So it's a pretty actually even mix of old and new. Our sponsorship, as we've talked about previously, is very traditional middle market sponsorship. And typically, that's three buckets: high net worth individuals, smaller funds, and then syndicated equity positions. So if you look at our forward pipeline, it just very much reflects the existing portfolio and the borrower structures there. In terms of what it looks like, we're seeing a lot of really interesting opportunities on the construction loan side of things. There seems to be a fairly large void in that space today. So we're leaning in on the construction loan book a little bit here. But other than that, it's typical of what we've been messaging to the market. We want to continue to originate multi-family. We want to continue to originate industrial. We are selectively originating hotel and finding the credit bar to be very, very high for office and retail in this environment.

And then as a follow-up to that, I'm assuming the construction loans are kind of the same mold that you guys like Southeast, Southwest, multi-family, industrial.

That's the entirety of our construction loan book.

Awesome. And then as another question, I got last one and then I'll jump out. You mentioned you guys are comfortable owning and operating. How comfortable would you guys be, I don't know, operating for say, two years? Or what's the duration that you guys would look to hold an asset for if needed?

I think we would let the market dictate that. Just from an operational standpoint, as you know, we run two equity platforms here as well, both the multi-family REIT as well as the Franklin Templeton value add equity portfolio. So we are very, very comfortable owning and operating real estate. And because of how solid our balance sheet is, how much liquidity we have, we don't feel like we need to be forced sellers in what is an overall difficult environment. So if we're able to achieve pricing that we think makes sense, we're a seller. If we're not, we will operate those assets. You know, to your specific question, it could be several years. But I think, we're not in the business in this vehicle of owning commercial real estate for an extended period of time. So we will look to exit hopefully in greener pastures if we're not able to execute today.

Ladies and gentlemen, this concludes our question-and-answer session. I’d like to turn the conference back to Lindsey Crabbe for any closing remarks.

Thank you for attending our call today. We look forward to speaking with you next quarter. Thank you.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.